No-Closing-Cost Refinance: What Is It, How Does It Work, And Is It Right For You?
Dan Miller9-Minute Read
November 17, 2022
A no-closing-cost refinance can be appealing, especially if you don't have a lot of cash to spare or you don't plan to live in your home for a long time. But there are also some downsides to consider before you apply, and depending on the situation, the costs may outweigh the benefits. It's important to understand both the pros and cons so that you can make the best decision for your specific financial situation.
If you're thinking about refinancing your mortgage with no closing costs, here's what you need to know.
What’s A No-Closing-Cost Refinance?
A no-closing-cost refinance is the same as a no-cost refinance or no-fee refinance. Doing a no-closing-cost refinance does not mean that you have avoided the borrower’s expenses that come with a loan. Your loan will still carry the typical expenses that you can expect from any mortgage refinance.
Instead, this type of loan allows you to refinance closing costs into your loan, so you don't have to pay them upfront. Alternatively, you can sometimes refinance without closing costs by having the lender pay them in exchange for a higher interest rate.
- Redistributing closing costs into the mortgage principal: One option for a no-closing-cost refinance is to redistribute the closing costs into your mortgage principal. If you choose to do this, the lender wraps the balance of the mortgage refinance into the unpaid loan balance, or principal. Because your total loan amount is higher, your monthly payments will be higher than they would be if you paid the closing costs at closing.
- Swapping closing costs for a higher interest rate: You can also choose to take a higher interest rate in exchange for the lender covering your closing costs. The lender may allow you to assume a higher interest rate to cover the cost of closing fees. The interest rate on your loan is one of the main things that determines your monthly payment, so a higher interest rate will increase your monthly payment. If you're planning on staying in your home for the full 30 years of a mortgage, this can mean tens of thousands of dollars in extra interest.
What Closing Costs Do You Owe When Refinancing A Mortgage?
In general, closing costs on a mortgage loan can range from 3% – 6% of the loan amount. The amount of the fees can vary depending on the lender and the situation. Here are a few of the most common closing costs you'll pay when refinancing.
Loan Origination Fee
The loan origination fee is charged by the lender to recoup their costs for issuing a loan or mortgage. The origination fee covers things like the application fee, underwriting, costs for funding the loan as well as loan processing. The amount of the loan origination fee varies by lender, but it is common for origination fees to be between 0.5% and 1% of the total loan amount.
An appraisal is an unbiased report on the market value of a particular piece of property. Lenders want to make sure they know how much the house is worth so they can determine the loan-to-value (LTV) ratio of the property. The appraisal fee can cost between $400 and $800 for a single-family home, while multifamily and commercial appraisals cost more.
Title fees are a group of fees that cover the costs of transferring and recording the deed and other closing documents. Title fees can also include purchasing title insurance for yourself and/or the lender as well as title searching fees.
Depending on the loan-to-value ratio of your loan, your lender may require you to pay mortgage insurance. Mortgage insurance is common if your LTV is higher than 80%. There are two common types of mortgage insurance, depending on whether you have an FHA or conventional loan.
Mortgage Insurance Premium (MIP)
Mortgage insurance premium (MIP) is required on FHA loans where the borrower has less than 20% equity in the home. There are two components to MIP – an upfront part that you will pay as part of the closing process and an annual component that you'll usually pay as part of your regular monthly mortgage payment.
The upfront MIP is typically around 1.75% of your total loan amount, while the annual premium is around 0.85% of your loan amount, though you can pay a lower amount if you put more money down. Unlike private mortgage insurance on conventional loans, MIP usually stays for the duration of the loan, regardless of how much equity you have. The only exceptions are if your loan was from earlier than 2013 or if you put more than 10% down at the start of your loan, in which case your MIP will be canceled after 11 years. If you want to get rid of your MIP otherwise, you will need to refinance to a conventional mortgage.
Private Mortgage Insurance (PMI)
Private mortgage insurance (MPI) is mortgage insurance for borrowers with conventional loans that have less than 20% equity. PMI is used to compensate lenders for the higher risk of default that comes with borrowers who have less equity. With PMI that comes with conventional loans, you can typically ask the lender to cancel PMI once you've reached 20% equity. That could come from paying down the loan, the house's value increasing or a combination of the two factors.
Credit Report Fee
A credit report fee is a fee charged by the lender during a no-closing-cost refinance or any mortgage application. The lender will need to check your credit score and run your credit report possibly multiple times during the refinancing process, and this fee pays for that service. Credit reporting fees can range anywhere from $20 to $100, depending on how many credit reports the lender needs.
Homeowner fees are fees associated with the actual home itself. This includes prepaid items like property taxes, homeowners insurance or homeowners association (HOA) fees. Your lender may set up an escrow account to collect your property taxes and homeowner's insurance (like many loans). What you may not realize is that you will also have to initially fund your escrow account at closing. This could be six or more months of your monthly escrow amount – possibly thousands of dollars due at closing.
Mortgage points – also called discount points – are a type of lender credit that you can choose to take advantage of if you can't or don't want to pay the full amount of your closing costs. The way that lenders calculate points is as a percentage of your total loan amount. Generally, each point is equivalent to 1% of the loan balance. You can choose to buy points (paying additional closing costs to lower the interest rate on your loan) or sell points (raising the interest rate on your loan to receive a credit toward your closing costs).
For instance, one point on a $250,000 loan would be $2,500 or 1%, while two points would be $5,000 or 2% of the total loan balance. Points are typically sold in one-eighth of a point increments (or 0.125% of the total loan amount). If you do opt to buy points, you will either pay or receive the amount at closing. Selling points can be one way to eliminate your closing costs during a refinance.
VA Funding Fee
One of the advantages of VA loans for active-duty members or veterans of the U.S. military, National Guard or military reserves is that you do not have to pay a down payment toward the purchase of your home. You also do not have to pay monthly private mortgage insurance. However, to help lower the costs of VA loans for taxpayers, there is a one-time VA loan funding fee that is charged at closing.
You will pay the VA funding fee in most cases (exceptions include if you have a service-related disability or received a Purple Heart for a service injury). If you are refinancing to a VA loan from a different loan type or if you are refinancing an existing VA loan, you may use a VA Streamline refinance or VA Interest Rate Reduction Refinance Loan (IRRRL). These types of refinancing have different requirements and benefits than other types of refinancing. The amount of the VA funding fee depends on the following factors:
- The type of loan
- The total loan amount
- The down payment amount
- Whether it’s your first time using a VA loan
What Are The Disadvantages Of No-Closing-Cost Refinancing?
While a no-closing-cost refinance comes with some attractive benefits, there are also some disadvantages that you'll want to be aware of.
Higher Loan Balance
One option you can choose is to roll your closing costs into the new loan. In other words, you're using the equity in your home to pay the closing costs on the refinance.
Let's say you're refinancing an existing mortgage loan with a $125,000 principal balance. The closing costs on the loan are $3,000, but you don't have enough cash to pay them. Instead of having the lender pay the closing costs, you can simply add them onto your new loan amount.
In this case, your new loan would be $128,000, and your interest rate would remain the same. Over 30 years, you'd end up paying $12 more per month and $4,700 more in total interest.
Increased Mortgage Rates
The other option is to use lender credits, where the mortgage lender essentially pays your closing costs for you. This way you still don't have to shell out the cash up front. In exchange, the lender charges the borrower a higher interest rate to recoup their upfront cost.
Let's take the same example as above, but instead of rolling the closing costs into your loan, the lender offers to pay your closing costs in exchange for increasing your interest rate from 3.25% to 3.5%.
If you were to agree, your monthly payment would increase by $17, and you'd pay $6,227 more in interest over a 30-year loan term.
What Are The Benefits Of Refinancing A Mortgage With No Closing Costs?
There are a few reasons you might consider a no-closing-cost refinance, even if it ends up costing more than if you were to pay upfront. Here are some of the advantages.
Preserving Your Emergency Fund
If you're considering a no-closing-cost refinance to take cash out of your home to pay an unexpected bill, you might be able to save on overall interest rates by choosing a refinancing option instead of using credit cards or taking on other unsecured debt.
In the same vein, keeping your emergency funds in your savings account instead of using them to pay closing costs can help prevent you from having to borrow in the future if something unexpected comes up.
Cashing Out Your Home Equity
One benefit of a refinance is the possible ability to cash out home equity. You could use the funds from a no-closing-cost refinance to finance a renovation, pay for college or pay down higher-interest debt. This can be an improvement to your overall financial situation.
Taking Advantage Of Lower Interest Rates
Even if you choose to have the lender pay some or all of the upfront costs for a higher interest rate, you may still be able to get a lower rate than what you're paying right now.
This can occur if you've built up a significant amount of equity, market rates have dropped significantly, or you've improved your credit score since you first took out the loan.
Avoiding Long-Term Costs
In the scenarios above, the additional interest costs are spread out over 30 years. But if you only plan on spending a few more years in the home, you may ultimately save money by having the lender pay your closing costs as part of the refinance.
For example, with the scenario where you roll the costs into your loan amount, a $12 increase in your monthly payment over 5 years would cost you $720 in total, which is much lower than the $3,000 you saved upfront.
The Bottom Line
The most important thing to understand about a no-closing-cost refinance is that it doesn't mean that you don't have to pay closing costs at all. Instead, you can choose to have the lender pay them for you. In exchange, you'll either have a higher total loan amount or pay a higher interest rate over the length of the loan. Still, there are several reasons why choosing to do that can make good financial sense.
If you understand the benefits and disadvantages of a no-closing-cost refinance and are ready to move forward, you can get preapproved now.
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